IFR Pfandbriefe Roundtable 2016: Part 2

IFR: Thomas, in conceptual terms could you foresee interest at any point in a European covered bond product operating alongside national covered bond regimes? It would give issuers an option of issuing a covered bond as normal – and that can be as cross-border or domestic as they want – or taking the other option of issuing a pan-European covered bond.

Thomas Cohrs, NordLB: That question is ammunition for a long, long discussion. A lot of people in this market tend to be a little dogmatic about this. Coming from a market that has a long history and a very reliable and successful product tends to make you a little bit negligent of other possibilities.

I am fairly open. If everyone uses a unified product, it might increase liquidity but that’s very far-fetched without knowing what it might resemble and bearing in mind all the potential pitfalls around deteriorating quality standards, which we’re very concerned about coming from a market with some of the highest standards,

So even with a lot of imagination it’s hard to foresee that. I also fail to see the benefits of that additional possibility next to all the well-established national frameworks that we have. In this respect, we basically have two options and as Jens has already described, the second options doesn’t look like a very sensible one right now.

Either we all use the same thing, and therefore hope we have a deeper market in all respects, or we had better stick to the ones we know, have been established with sound qualities and a decent degree of market acceptance. I don’t think there is anything in-between at this stage or over the next five to 10 years.

Jörg Huber, LBBW: It’s also a question of who will benefit from something like that. The European Commission thinks harmonisation means products are easier to understand because everything is the same. But I wouldn’t say investors will derive big benefits from it.

Investors are prepared to deal with different kind of products. If they don’t have the expertise to go into all of them, they can focus on one or two while the bigger accounts that have the expertise can play the markets and say: “OK I’m in risk-on mode so I’m going into the lesser-rated or lesser-quality jurisdictions”. If not they can go to the other end of the spectrum.

[In moving to a European covered bond], we will completely take away this opportunity of allowing investors to manage their portfolios in such a way.

Götz Michl, Deutsche Pfandbriefbank: From a risk point of view, diversification is something positive! If we just had one covered bond regime in Europe, and if something went wrong with the system or if we had problems in one bond, the whole market would probably suffer. The question really is whether there is a substantial benefit for a capital market with just one covered bond product.

Frank Will, ECBC: We need competition between legal frameworks. If one framework or one regulator comes up with some good ideas, say, around liquidity buffers, there’s a strong incentive for other jurisdictions to follow. If you have one legal framework, it would be very difficult to get everybody on board supporting changes.

There is a risk that everybody ends up focusing on the lowest common dominator. So I think it is quite important to have this opportunity for national regulation to set incentives for others to follow.

Thomas Cohrs, NordLB: Just so we don’t all sound too negative on the harmonisation project, I would reiterate the potentially positive point around liquidity. This is something that needs to be addressed. We all complain about the lack of liquidity in every single market we work with, on covered bonds and in the market overall.

The most successful capital markets tend to be in the US. They don’t have different legislation for mortgage-backed securities in the individual states, or different capital markets in Florida versus California or New York. To all intents and purposes, the US has the most liquid secondary debt market in the world.

So there could be an argument for trying to increase overall liquidity by having just one product. And you could still have competition by looking at the various underling pools, just as you do right now. You just take away the complexity of having to compare various legal frameworks.

I do think there is potential benefit in that. However, as long as we do not have a unified or harmonised legal background across all these jurisdictions in the European Union, it is a completely moot point. We are starting to work on something that is a very fine detail in a much larger picture where we haven’t done our homework yet. So as far as I am concerned, it’s a completely wrong angle to begin with.

Sabrina Miehs, Helaba: I would also like to be a little bit more positive. I obviously agree that we don’t want to dilute well-functioning covered bond frameworks, such as Pfandbriefe, which for our investor base is the product they benchmark everything else against. But on the other hand we have seen some instability because property is not properly revalued in Spain or because assets in a cover pool are not liquid.

If you think of the structural elements of covered bond frameworks that are not nationally determined, such as liquidity reserves, or which stress test you have to run – which reside on a structural level – we could get some improvements in some legislation which would make it easier for investors to understand those frameworks because they are coming from a minimum level which is the same, so elements such as a single authority looking after the cover pool monitor rules; items that do not disturb the national laws.

Every nation has its own history and there are so many inter-linkages that I don’t think there can be harmonisation. But in terms of the structural side around interest-rate, currency and liquidity risk, you could recommend some enhancements or we could move to a directive where we could improve the European frameworks on average. That is something the investors I talk to daily would welcome.

Jens Tolckmitt, VDP: I think everybody around the table basically agrees that a certain degree of harmonisation and defining stricter rules not only can be but will be of benefit to the product. Not only because of the regulatory treatment of the product but basically for the product and the market as a whole. And there are benefits to harmonisation.

The problem is that coming from a lobbyist perspective and dealing a lot with European and global institutions, you encounter a kind of déformation professionelle where you have the feeling that basically they think they can harmonise everything to the bitter end. At some point you have to say to them: “look, we have existing regimes that work. We don’t need a new product that replaces them all”. It is important to put a break on this endeavour to harmonise everything.

From a European perspective, you can harmonise banking supervision, you can harmonise prospectuses; you can harmonise almost everything. The question is, does it really benefit the people around Europe that invest in these products or use these products? Or, in terms of banking supervision, are we supervised by a European supervisor?

Sabrina Miehs, Helaba: I agree with Frank that if you don’t allow flexibility in national legal frameworks you lose innovation and you lose possible reactions to certain market developments in individual countries, according to their frameworks and according to circumstances specific to their markets.

So I would really warn about that. You need flexibility for competition and innovation and I would doubt that any one of those politicians could put their hand in the fire and say they are aware of all the consequences and indirect effects that harmonisation or common laws have. There are so many consequences that will become apparent over the years that you can’t really expect or be evident now.

IFR: Frank just to bring this segment to a close, what would be your best guess as to where this all ends up and what would be the timeframe for all of that to happen?

Frank Will, ECBC: Let’s start with the timeframe. Following the Brussels covered bonds conference in February, the Commission is seeking external advice: there is a six-month study underway that which will be finished later this year. After the study, we will get more guidance.

But as I said earlier, we expect there will be most likely some form of principles-based harmonisation. I think the Commission got clear feedback that the industry is concerned about any wide-ranging harmonisation of the covered bond product. Reflecting on what Sabrina and Thomas said, I don’t believe that changing the laws in certain areas will suddenly work its magic and in the next crisis investors from France, Germany or the Nordics will jump into Spanish covered bonds.

There was a reason for what happened at the time of the eurozone sovereign crisis. People were concerned about the banks; they were concerned about the countries; they were concerned about the mortgage markets in certain countries. That’s why domestic investors were more comfortable buying than non-domestic buyers.

Changing the legal framework a little here and there will not change that. Even if we have one legal framework for all, it will not work. If you talk to the European Commission, they are clever people who understand the main driver behind that. That is also the reason why they have put this whole consultation paper outside of the Capital Markets Union stream. They didn’t really want to be on the same track; they wanted to be more flexible.

From an industry perspective we hope that having 750 stakeholders and other associations commenting in the same direction will be taken on board by the EC ensuring that the covered bond markets will continue to function.

Sabrina Miehs, Helaba: I also see an educational point with this initiative. We haven’t talked yet about transparency, which for me as a primary credit research analyst is very important. We have seen a lot of improvements in national transparency templates and they’re being filled in more and more, which is very welcome.

For me, initiatives around covered bond harmonisation with regard to transparency are like a mirror if they force more information into transparency templates and issuers get behind the initiative, or see incentives to allow for more data.

It is not just for investors. I sometimes have the feeling that this is an education for issuers to see what is in their pools in comparison with other issuers and nations. In Spain, for example – and I’m talking about my former position as a ratings analyst – the data was really poor, even for ratings agencies.

So there is an education process. It is always good to benchmark and to compare and to bring this to the surface. I absolutely welcome above all the transparency initiative as part of this harmonisation process.

IFR: Jens, the German Pfandbrief Act celebrated its 10th anniversary last year and the product had a very long history prior to that. How does that sit with the technocrats in Brussels? Do they understand that the product has had a long and unblemished history? What kind of impact do you think this has on their deliberations and their mindset?

Jens Tolckmitt, VDP: History alone is not something that has a very important impact on regulators. But if you look at what the EBA and the Commission have written, you can clearly see the footprint of the Pfandbrief in the overall approach. I do think that the people we are talking to at the Commission are very sensible and aware of the value of national regimes; amongst them the Pfandbrief.

Having these strong regimes helps convince them or pushes them towards a more flexible approach in terms of not wanting to harmonise to the very end and to have a European covered bond, but keeping strong and functioning markets and products in place. That is maybe the main impact.

If you go into the details, they told us they have taken a lot of issues from the German Pfandbrief Act and in the end this is the value of keeping your product up-to-date and regularly amending the law.

IFR: Why do you think the Pfandbrief is the best template?

Jens Tolckmitt, VDP: We have had a history of constantly amending our law and addressing the issues that came up in terms of what market participants expected from the product and from issuers. That makes our product quite modern and quite up-to-date.

That is a good starting position that fits well into a harmonised template. But that certainly does not mean that there is nothing left to do with the Pfandbrief. If you were to put the final European framework above the Pfandbrief Act, we would find areas where we may have to work, which is fine but which is basically what we are already doing constantly.

But in terms of the overall fit between the Pfandbrief and the elements of the Pfandbrief framework in the potential European framework, there will be a strong resemblance between the two. That is a good starting point.

IFR: Götz, you were saying earlier that foreign investors had dropped out of your books. Is that a good blueprint, in light of moves to a European covered bond product?

Götz Michl, Deutsche Pfandbriefbank: I think it is a question of price. Since we issue at very low levels, foreign investors just drop out. If we have a 29th regime and we all issue at a higher spread level, I guess we will have foreign investors but at a higher price, which is a disadvantage for German issuers.

IFR: I wanted to move on to 2016 funding requirements and what we can expect to see from covered bonds in Germany this year. Sabrina: what are your estimates as to what we might see in gross and net Pfandbrief issuance in 2016?

Sabrina Miehs, Helaba: For covered bonds as a whole, we’re forecasting €150bn, of which €28bn in benchmark Pfandbrief issuance, with maturities of around €24bn (depending on what you include). So we see more supply than redemptions in Germany. We have a growing economy and a growing mortgage market that should lead to more supply.

IFR: Thomas, do those numbers chime with yours? What opportunities for issuance might be afforded by commercial and residential real estate growth in Germany and elsewhere?

Thomas Cohrs, NordLB: The mortgage business certainly hasn’t been booming for all issuers because there is a lot of shifting from other assets into real estate going on Germany due to asset inflation in some places. The more this starts to cover the whole country, we will probably see more people entering the market that do not have assets to switch who will have to take on mortgages, which a lot of banks are extremely eager to sell.

That may have its own dangers but I would still think that if the market situation in terms of interest rates does not change and the way alternatives asset classes i.e. equities are behaving continues the way they are at the moment, I would expect more mortgages to be written on the residential side.

We’re already seeing it on the commercial side. That is another story and we have seen strong growth everywhere in Germany. On the residential side, I don’t think we have seen it yet but it is starting to happen and the more that happens the more bonds we will see.

We’re not yet at the stage where this will reach the proportions we have seen in the UK, Ireland, or Spain for that matter, but we are on the way there and so maybe some warning bells should ring there as well.

In terms of issuance, it will be more than offsetting the loss of public sector Pfandbriefe that we all have suffered over the years since the Landesbanken stopped issuing based on cover that is not available any more. So in general, our numbers chime very well with Sabrina’s.

Jens Tolckmitt, VDP: Overall, we expect an increase in overall issuance to around €57bn, of which mortgage Pfandbriefe will account for €43bn. That’s more than redemptions and that is new. The other thing that is new is that last year, and likely also this year, we are meeting or even exceeding the expectations we had at the beginning of the year.

Over the last few years, we have had an actual turnout that was less than was expected or planned at the beginning of the year. That changed last year and is quite positive, as overall Pfandbrief volume is now stabilising as a consequence of that.

Frank Will, ECBC: 80% of redemptions in the Pfandbrief market are in the first half of the year. If you are an issuer thinking about timing and you see a risk that the ECB might slow down its purchases, maybe you are better off trying to be more active in the first half than the second half of the year.

One of the reasons we saw more issuance last year was that some issuers pre-funded and said: “let’s be on the safe side”. Maybe the new-issue premiums will be slightly lower in May/June but we are concerned that spread levels could be wider.

In general for the overall covered bond market, we would expect that a lot of issuers will try not to gamble and leave it to September, October or November, hoping that the ECB is still buying big size. Many will probably try to get a large part of their funding done in the first half. So we expect more issuance in the first half than the second.

IFR: Jörg, in terms of 2016 what lies ahead for you as an issuer? How are you viewing the currency issue? Is there still a role for registered issuance (private placements, Namenspfandbriefe) in your overall funding mix?

Jörg Huber, LBBW: Our covered bond requirement is in the region of €5bn and about 75% to 80% will come in benchmark format. Private placements are in our portfolio but as I mentioned earlier, things have changed on the Pfandbrief side due to the very low interest-rate environment. The domestic investor base that bought about 80% of our issuance every year is not there at all at these low levels.

That means even with a registered transaction you can’t get their interest. Also, a lot of investors have different requirements. They need more liquidity so we will see the trend which we already saw last year of our issuance continuing more in benchmark format than in private placement format. Pfandbrief private placements won’t go away completely but we will focus much more on benchmark transactions.

At the lower maturities, out to three/four years, it is not really possible to issue in euro-denominated format because you would need to offer negative yields and you can’t sell Pfandbriefe at negative yields. When it comes to these kinds of maturities, we will definitely look at the possibilities to issue in other currencies and predominantly in US dollars.

There, our investors – even our traditional German investors – can get yield pick-up with quite a stable currency environment. This is a route we are certainly focusing on this year.

IFR: Götz, can you take us through your requirements for the year and your thoughts as to where and how that gets executed?

Götz Michl, Deutsche Pfandbriefbank: It’s quite similar. Like Jörg said, Namenspfandbriefe are much less important than in previous years. We, too, focus on benchmarks and of course look at foreign currencies. With funding plans, we have to see during the year what the repayments on the assets side are. On the commercial mortgage side, we have experienced early pre-payments. Obviously if a borrower sells a property the asset is not on the balance sheet any more but the funding is still there.

Our overall funding naturally depends on what the assets side is doing. In 2014, pbb´s new business stood at €10.4bn; after nine months of 2015 the bank almost reached €9bn. These figures obviously aren´t automatically reflected in new funding because we have amortisations on the balance sheet, and pre-payments on the assets side are stronger than the melt-down on the liabilities side. So we always need to look at the net growth of the balance.

More from IFR Roundtable magazine

In terms of Pfandbriefe funding, borrowers present at the IFR Roundtable were crystal clear: that the year ahead was expected to be volatile so they were fully prepared to jump on windows of opportunity as they presented themselves. That means a high and constant degree of preparedness to issue – and in benchmark format wherever possible. Negative yields at the short end will either push them out along the curve or tempt them into non-euro issuance as a possible alternative. All of that said, yields and spreads are such that they were confident they would be able to continue capturing good funding levels. On green matters, it’s fair to say IFR’s panel was less than enthusiastic. The product on the bond side tends to continue being seen as a marketing gimmick in many quarters. But given that investors are increasingly focused on the environmental theme, that fact alone is likely to drive interest from a funding perspective although no-one expects dramatic growth in green Pfandbriefe. As for the regulatory aspect, IFR’s roundtable was neatly placed between the January 6 response deadline to that EC consultation and the Commission’s own covered bond conference in Brussels on February 1. In that regard, the discussion moderated by IFR was perfectly placed to gain an early flavour of responses to the consultation. IFR panellists were concerned at the potential direction of travel here. Of course, it’s perfectly reasonable for the Commission to want to understand why the cost and performance of Europe’s national covered bond markets during the eurozone sovereign crisis diverged to the extent they did and to account for the reversion of investor behaviour to national boundaries. But creating a so-called 29th regime that would exist side-by-side with existing national frameworks and act as a harmonised, standardised pan-European alternative was roundly rejected as a viable option. There was a very clear consensus around the IFR table – and in the market generally – while such a concept might improve liquidity on paper, there is no real need for a pan-European product. National markets have more than proved their robustness. That doesn’t mean to say they aren’t open to incremental improvements – they are – but the fear is that a new European product acts, in the words of one panellist, as a Trojan horse from Brussels that will come with a whole network of incentives for market participants which will act perversely and unnecessarily to disrupt existing regimes. To see the digital version of this roundtable, please click here To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com <object id="__symantecPKIClientMessenger" style="display: none;" data-extension-version="0.4.0.129" data-install-updates-user-configuration="true"></object>

Götz Michl Deutsche Pfandbriefbank Götz Michl is head of funding and debt investor relations at Deutsche Pfandbriefbank (pbb), where he has been working since 2010. Before his move to pbb, he was head of German real estate for RBS. Prior to joining RBS/ABN AMRO, he worked for 10 years at HypoVereinsbank in a variety of positions. Sabrina Miehs Helaba Sabrina Miehs is a senior covered bond analyst at Landesbank Hessen-Thüringen (Helaba). She mainly covers covered bonds from Germany, France and Spain but follows broad market developments. Prior to Helaba, Sabrina worked for 11 years at S&P, latterly as deputy analytical manager where she took up responsibility for European covered bonds. Frank Will HSBC Frank Will is chairman of the ECBC Working Group on Legislation and is global head of covered bond research at HSBC. Before joining HSBC he was head of covered bond/S&A research at a global investment bank and a senior bank analyst for a German bank in London. Jörg Huber LBBW Jörg Huber is head of funding and investor relations at Landesbank Baden-Württemberg. He joined LBBW in 2002 to build up primary business activities in Europe. Prior to joining LBBW, he worked at DZ Bank as head of new issues, and JP Morgan as head of syndicate, starting his career at Deutsche Bank, where he worked in various areas including capital markets and debt syndicate. Thomas Cohrs NordLB Thomas Cohrs is head of FIG and SSA syndicate and origination Norddeutsche Landesbank. Prior to joining Nord LB in 2010, he was executive director, DCM at Calyon/Credit Agricole CIB, covering Germany and Austria, and a director in DCM at Unicredit for 15 years. Jens Tolckmitt Verband Deutscher Pfandbriefbanken Jens Tolckmitt has been chief executive of the Association of German Pfandbrief Banks (vdp) since June 2009. Between 2003 and 2009, he was the managing director of the Association of Foreign Banks (VAB) in Germany. Prior to that, from 1998 to 2002, Tolckmitt worked for the Association of German Mortgage Banks in Bonn and Berlin in several roles. Helene Durand IFR Keith Mullin Editor-at-Large, IFR To see the digital version of this roundtable, please click here To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com

IFR: Welcome to IFR’s 2016 Pfandbrief Roundtable. As ever, there a number of interlocking themes that I wanted to pick up on in our conversation: the current market environment (both primary and secondary) in the context of both the redemption calendar and the impact of the ECB’s ongoing Covered Bond Purchase Programme, and against a backdrop of volatility in global credit markets; and how 2016 might pan out in terms of funding requirements. I also wanted to spend some time on the harmonisation process and the European Commission’s covered bond consultation paper. What are the prospects for Green and SRI covered bonds? But let’s kick off with the current market. This year has been busy so far, with issuance from borrowers out of Canada, UK, France, Austria, Spain and of course Germany. Thomas, could you give us a wrap? Thomas Cohrs, NordLB: The main theme we’ve observed since the beginning of the year is that covered bonds are still very much in demand when markets look jittery – as long as they’re not too jittery. As you mentioned, we have seen a number of issues from various jurisdictions. Those I would mention most notably in that context would be non-European borrowers or borrowers from outside of the eurozone that are not eligible for the ECB Covered Bond Purchase Programme. They seem to have had the best run with investors. There have been exceptions to this, though. In terms of Norwegian issues, for example, you had the country’s major issuer [DNB Boligkreditt] having no problems printing a €1.5bn transaction whereas a smaller issuer with similar quality from the same country [SR-Boligkreditt] didn’t find it quite as easy to fill even a €500m book at a higher spread because of its lesser recognition. That is mirrored with the Canadians and will likely be the case with issuers from regions far beyond Europe – from Asia, Australia and New Zealand. We haven’t yet seen those coming to the market this year but they will. Within the eurozone, Pfandbriefe have the benefit of being the tightest product, and we have seen more issuance intended and waiting to come to the market. The deals we have seen so far have tended to be from the safest sources. For example, we’ve had two Landesbanken issuing [BayernLB and LBBW] and we are waiting for more to come. The usual suspects for potential spread widening i.e. peripheral issuers or even French issuers have seen their fair share of issuance, with various degrees of success. We saw a very successful deal coming in the belly of the curve that amassed an order book not too far away from €2bn but they had to pay a new-issue premium of around 8bp, shifting the whole French curve up. And then we had an announcement from another French issuer at the longer end of curve that has not come to market yet, but that announcement alone shifted the curve up. The upshot being that whenever we see new issues coming, the requirements for new-issue premia tend to be higher than originally expected and they have effects on the secondary curve that people fully expect but still seem surprised when they see it. This is especially evidenced in the surprise we get from investors when they try to switch out of existing bonds that appear to have tightened in order to take profits and position themselves for new deals, and find that the mere action of trying to switch out changes the price and they barely end up with a profit at all. I expect that phenomenon to continue throughout the year. Why is that? The ECB is playing the role of the puppet-master here in many respects but it’s not only that: there have been shifts in investor interest as well. But in general I still think it is going to be a better year for covered bonds in terms of primary issuance. I continue to be very negative in terms of secondary liquidity but on the other hand that ensures a further role for intermediaries like ourselves, which is a good thing. I think the covered bond product is going strong, as we expect it to. IF

IFR: To Thomas’s point, will you both be looking to get the bulk of your funding out of the way in the first half, pending a potentially uncertain second half? Götz Michl, Deutsche Pfandbriefbank: Every year, a funding manager tries to do as much as possible in the first half but of course we need to use market windows and for the next couple of months we will use them as we described. We always look at the market and are prepared to issue. If there is a window and we think: “OK, we can issue a Pfandbrief” we will probably do it. [pbb announced its first Pfandbrief of 2016 on January 12, a €750m due 2023 and followed up with a €500m due 2022 after the IFR Roundtable took place on February 21.] If you get too much funding in by, say, March/April, then we will want to slow it down. With our first issue done at the beginning of the year, there’s an argument not to issue until May or June simply because we do not really need the cash position. That said; if the opportunity is there and there is a good market window, we would probably issue. That is driven not so much from the fear that the second half will be worse but simply knowing if there is a good opportunity to issue, you had better use it and not wait for a good window in September that might not be there. Jörg Huber, LBBW: Over the last few years it has become so important to use windows when they come. It is not the case any more like it was in the past to say: “OK at the beginning of the year, real money accounts are cash-rich so it’s a good time to issue. And then again after the summer break and there might be some times in-between”. Nowadays if there are windows and the markets are strong, that’s something we should really focus on. And if they are all in the first half of the year and if it’s do-able, you should concentrate on that rather than saying you’d like to spread your funding over the whole year. Thomas Cohrs, NordLB: My own institution is not quite as flexible in this respect and I would guess there are issuers that work similarly. I would love from a syndicate point of view to do exactly that; if the market is there let’s issue what we can issue. But the problem is you may look a bit desperate if you are issuing too much in too-short a timeframe so it is always a question of market perception in this respect. And our treasury likes the idea of funding plans; they are just not up to saying: “we’re going to fund €10bn this year so do whatever you like with whatever product you like whenever the market is there”. I would love that. Instead, they tell me: “You want to do a deal? OK you have permission to do exactly this type of deal within these types of parameters and after that we’ll talk about the next possibility over the next three months or so”. So in this respect we have taken a bit more of a Statist approach, if I can call it that. I would be surprised if everybody who needs to do even significant amounts of funding will do that whenever there is a window, as early as possible. There will be a lot of people, who for various institutional constraints, will have to stagger this over the year. IFR: How receptive are non-eurozone markets to Pfandbrief issuers? How successful have you been and how much appetite is there? And what are the conditions like for you to access these markets? Do you have targets that you want to hit in terms of levels or is it purely diversification and opportunity? Götz Michl, Deutsche Pfandbriefbank: For us it is quite easy. We look for the currencies where we have assets. That’s very important from the perspective of rating agencies but it is also important for the cover pool to have the same currency. Any currency mismatch is negative so we would currently not issue an Australian dollar Pfandbrief because we don’t have assets nominated in Australian dollars in the cover pool. We have Swedish kronor assets so we look for Swedish kronor liabilities, which works in smaller tranches. That increases the inv